Updated on October 4, 2023
Credit scores are among the first points of reference while disbursing a loan. The meaning of this term and its importance in any loan is given hereunder.
Meaning of credit scores
A credit score is a numerical representation of an individual’s creditworthiness. Credit scores are generated by credit bureaus like CIBIL (Credit Information Bureau India Limited), Equifax, Experian, and CRIF High Mark. These scores are based on an individual’s credit history and financial behaviour. They typically range from 300 to 900, with higher scores indicating better creditworthiness.
How are credit scores credited?
Credit scores are generated through a complex algorithm that takes into account several factors from an individual’s credit history. The most significant factor is the payment history, which assesses whether loans and credit card bills were paid on time, with late payments or defaults negatively impacting the score. Another critical factor is credit utilization, which measures how much available credit a person uses, with lower balances relative to the credit limit having a positive effect. The length of one’s credit history is also considered, with longer histories often seen as advantageous. A diverse mix of credit types, such as credit cards, loans, and mortgages, can positively influence the score, while opening numerous new credit accounts in a short timeframe can have a detrimental effect, potentially indicating financial stress.
What is the importance of credit scores?
Credit scores are pivotal in a financial system, particularly for loans. Lenders, including banks and NBFCs, rely on credit scores to assess loan applications. A higher score enhances loan approval chances and can lead to lower interest rates and larger loan amounts. Additionally, borrowers with better credit scores often receive more favourable loan terms, such as extended repayment periods.